Homework 23: Key

1.	a.	Suppose that the private (inverse) demand for subscriptions to internet services (based on the private marginal benefits (PMB) of individual internet users) is: P = 32 - 2Q and that the (inverse) supply is given by the following marginal cost equation: MC = 8 + Q. Equilibrium values: Q: 8 P: 16 P = MC => 32-2Q = 8+Q => Q=8 Q = 8 => P = 32 - 2(8) = 16.
	b.	Use the axes to the right to show the private market equilibrium in a supply and demand diagram.
	c.	Suppose that subscriptions to internet services generate beneficial "network externalities," since the value of the service to each user rises if there are more sites available to interact with. Suppose that these network externalities are given by: XMB = 1Q. At the social optimum: Q: 12 MC: 20 PMB: 8 SMB = PMB + XMB = 32-2Q + 1Q = 32-Q. SMB = SMC => 32-Q = 8+Q => Q=12 MC = 8+Q = 8+12 = 20 PMB = 32 - 2Q = 32 - 2(12) = 8
	d.	Add a social marginal benefit (SMB) curve to your diagram, and indicate the welfare loss of the private market equilibrium. See shaded triangle in diagram.
	e.	How large a subsidy would be necessary to push the market equilibrium to the social optimum? Explain briefly, and illustrate it in your diagram. Sub* = XMB at Q* = 1Q* = 12. (This also = MC-PMB at Q* = 20-8). In the diagram, this shows up as the distance between SMB and PMB at Q*.

2.	This question concerns the supplementary readings selection, Case study: Economics 101 at Big Tobacco U
	a.	It has been argued that smoking causes external costs (XMC). In the diagram to the right, illustrate the market for cigarette smoking and depict the typical externality analysis of the market See diagram to right
	b.	What public policy would help internalize the externality you have illustrated? Use a per-unit tax on smoking in public = XMC at the optimum to discourage excessive smoking in public.
	c.	Now illustrate in your diagram how the claims of the Philip Morris study described in the article would show up in the diagram. XMB makes SMB higher than PMB.
	d.	What (perverse(?)) public policy would be consistent with the claims of the study? A per unit subsidy to encourage more smoking.

3.	The following passage comes from a 2008 article in the Los Angeles Times: "One neighbor loves his solar panels, which have cut his energy bill and are helping to combat global warming. The other neighbor adores his trees, which boost his property value and capture greenhouse gases." Consider the following two alternative property rights assignments:
		(1)	Under traditional land rights, a land owner has absolute rights of usage "of a territory demarcated horizontally by boundaries drawn upon the land, and extending from there vertically downward to the depths of the earth and upward to the heavens."
		(2)	California's Solar Shade Control Act, property owners whose trees block the sun from more than 10% of their neighbors' panels can be fined as much as $1,000 a day if they refuse to trim them.
	Your goal is to promote economic efficiency.
	a.	How would you decide which alternative to recommend to if transaction costs between neighbors are negligible? It wouldn't matter: "Just do it." With negligible transaction costs, the Coase theorem applies, and any assignment will work out since the parties can bargain to the most efficient outcome.
	b.	How would you decide which alternative to recommend to if transaction costs are prohibitively high? I would have to try to figure out which option best promotes social welfare, and assign rights in the way that achieves that outcome most efficiently. For example, if the joint costs to society are lower if the tree-owners trim their trees, then I would impose the fines under option (2).